Wednesday, September 2, 2009

Structural, frictional, and cyclical unemployment

In my previous unemployment week posts, I explained what the unemployment rate means and how economists look at the consequences of unemployment, both in the long run and in the short run. Today, I revert to a more classical description of unemployment that may shed some light on why unemployment is so persistent during this recession.

I classify unemployment into three types: Each is defined with reference to the reason that people are unemployed.

First, there's frictional unemployment, which occurs naturally in any economy. People have to search to find an employer who needs their specific skills. Finding the right employee-employer match takes time and energy. Individuals have to look for the right job, and firms have to screen individuals for the right qualifications. This takes some time. Therefore, there will always be some level of unemployment in the healthiest of economies.

Second, there's cyclical unemployment, which rises and falls with busts and booms in the macroeconomy. When the economy is booming, cyclical unemployment declines. In ordinary recessions, cyclical unemployment rises.

Finally, there's structural unemployment, which comes from a fundamental imbalance between the skills of workers and the needs of employers/industries to utilize those skills.

For example, if too many people invested in financial services skills because of a bubble in the financial sector, then we should expect structural unemployment in that sector just after the bubble pops. The level of structural unemployment will decline as people acquire skills necessary to switch industries.

The industries in any economy are declining and rising dynamically over time. As a result, there's never a perfect match between the skills employees have and the jobs employers are offering. Therefore, some structural unemployment is inevitable. Nevertheless, in hard times, when several important industries go bust or contract sharply (as is the case with the housing bubble and financial meltdown), there's a large degree of structural unemployment.

And, I expect that is a significant component of our current unemployment woes. Big auto companies are either going under, or laying off a significant fraction of their workforce; Financial firms have gone bust. And, these events have left many individuals with specific skills that are no longer in high demand.

So, what does this mean for our current unemployed workers?

First, if you are a worker in one of these suffering industries, my advice to you is to look at your skill set and ask whether you can use your skills in some other industry or occupation. If you're lucky, you can. If you're unlucky, I would suggest developing skills that make you employable elsewhere. That's rough advice, but if your industry has gone away, it's the best advice I can offer.

Second, if you are a policymaker trying to make economically sensible policy, I would suggest that you emphasize programs that retrain workers in these blighted industries. The natural temptation is to prop up these old industries with programs like Cash for Clunkers, but that's not a good idea. Subsidies to the auto industry will merely encourage people to stick with a dying industry longer than they should.

The declining auto industry is a signal that our workers should be trained to do something else. It may be painful to retrain our unemployed workers now, but that's a better option than setting them up for another collapse several years from now. If the government is compelled to intervene, it should offer workers the option to find employment elsewhere.

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This is the fourth article for unemployment week on This Young Economist. In tomorrow's post, I discuss the relationship between mandatory employee rights and unemployment. See you tomorrow.

9 comments:

  1. Good post Tony :) Didn't know about the three types of unemployment -- interesting!

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  2. Same as Sarah, I didn't know about these three types of employment. Thank you for sharing this information with us. And I agree with your tips. If people are from these dying industries, they should broaden their job search. They could learn new skills in order to get a job in another industry.

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  3. You just helped me with my Macroeconomics homework. Thank You! :)

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  4. Thank you tony this was a great clarifying document

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  5. thanks tony tomorrow is my exam and most important topic.

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  6. What about Seasonal Unemployment?

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    1. Seasonal Unemployment -- unemployment that varies predictably by the calendar month -- is interesting. I would say that this is mostly frictional unemployment. Some jobs are temporary, and a transition between seasonal jobs is a natural thing to have happen.

      Note: Most of the employment figures that are reported in the headlines are seasonally-adjusted -- that is, they net out the predictable movements in unemployment from seasonality.

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  7. Can you relate these terms to the "natural rate" of unemployment?

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  8. Very useful, it clear my mind about being doubtful about what Structural Unemployment is all about BUT i will appreciate it if you can explain the kind of unemployment that is associated with change is Production Techniques. Thank you

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